How do banks adjust when faced with a sudden rise in capital requirements? The most frequent response, in the theoretical literature, is that they reduce lending or “deleverage” (see, e.g., Aiyagari and Gertler (1999); Gertler and Kiyotaki (2010). This is particularly true in crisis episodes when raising equity can be costly. However, in a new paper co-authored with Hans Degryse and Artashes Karapetyan, I show this is only part of the story. Banks may also ask borrowers to provide more collateral; collateralised exposures carry lower risk weights on average and hence enhance capital ratios. This requirement can adversely affect young and new borrowers that typically lack collateral to pledge and are also unlikely to have longstanding banking relationships.
Sebastian de-Ramon, Bill Francis and Kristoffer Milonas.
Navigational aids are helpful when visibility is poor or when landmarks are unfamiliar, especially when journeying to new destinations. In a recent working paper, we introduce a new regulatory dataset, the ‘Historical Banking Regulatory Database’ (HBRD), that provides a clearer view of the UK banking sector and helps navigate issues difficult to explore with other datasets. This post describes the HBRD, its benefits for research and policy analyses, and what can be learned from it.
Last year the Bank organised a research competition to coincide with the launch of the One Bank Research Agenda. In this guest post, the authors of the winning paper in that competition, Roy Zilberman and William Tayler from Lancaster Business School, summarise their work on optimal macroprudential policy.
Can macroprudential regulation go beyond its remit of financial stability and also contain inflation and output fluctuations? We think it can and argue that macroprudential regulation, in the form of countercyclical bank capital requirements, is a superior instrument to both conventional and financially-augmented Taylor (1993) monetary policy rules. This is especially true in responding to financial shocks that drive output and inflation in opposite directions, as also observed at the start of the recent financial crisis (see Gilchrist, Schoenle, Sim and Zakrajsek (2016)). This helps to effectively shield the real economy without the need for a monetary policy interest rate intervention. Put differently, a well-designed simple and implementable bank capital rule can achieve optimal policy associated with zero welfare losses.
Following the global financial crisis of 2007-08, financial reform introduced time-varying capital requirements to raise the resilience of the financial system. But do we really understand how this policy works and the impact it is likely to have on UK banks’ largest activity, mortgage lending? In a recent paper we investigated the UK experience of time-varying microprudential capital requirements before the financial crisis. We found that an increase in this requirement intended to make a bank more resilient actually induced it to shift into riskier mortgage lending.